Issue 11.08 - August 2003



Fat Pipe Dream

Softbank founder Masayoshi Son lost $75 billion in the dotcom crash. His new master plan: superfast, supercheap DSL for the masses.

By Brendan I. Koerner

"My dream is big, OK?"

Coming from a man who used to boast of having a 300-year business plan, that's saying a lot. But Masayoshi Son isn't exaggerating. His latest master plan includes nothing less than the demolition of Japan's telecom industry, and, not incidentally, the revival of his moribund company, Softbank. To get there, he's hawking next-generation, superfast, supercheap DSL to the Japanese masses.

He may no longer be the world's eighth-richest man - Softbank's stock price is down 98 percent from its bubble peak - but Son still moves with an impressive entourage. A cadre of yes-men, crowded around him in a Tokyo conference room, nod anxiously as their diminutive, balding maestro tries to sell me on Softbank's improbable makeover from venture capital washout to broadband pioneer. "We are the first service to have a pure IP-based network," crows Son, his placid face betraying an I-told-you-so smirk. "It is more powerful than anything else that exists around the world."

Softbank has spent close to $2 billion building out a gigabit Ethernet network and leasing copper wire from Japanese telecom giant Nippon Telegraph and Telephone. The result is a service, offered under the Yahoo! BB brand, that provides Internet access to Japanese homes at 12 megabits per second - eight times faster than what Americans are used to - for about $21 a month. Every day, as many as 7,000 new subscribers fire up their plug-and-play DSL modems, making Yahoo! BB the world's fastest-growing broadband service.

So things are looking rosy, right? Not quite. Softbank is spending $250 to acquire every new customer - $50 million per month. Outside Tokyo subway stations, rain or shine, cute teens in white Yahoo! BB mackintosh coats hand out a free modem to anyone who breaks stride. A second-rate baseball team, the Orix Blue Wave, now plays in Yahoo! BB Stadium. Such marketing gambits increase the company's profile but only add to Softbank's staggering $3.9 billion debt.

The safe move, given such a financial mess, would be to lay off workers, slash budgets, and curb investment - as so many stateside VCs and IT companies have done. But that's not Son's style. This is a man who poured nearly $400 million into Yahoo!, $100 million of it when the company was a 15-person nothing. He's a high-roller who would rather go all-in on a pair of deuces than fold.

Of course, Son believes he's holding more than a pair of deuces. He thinks the Japanese appetite for broadband connectivity makes the climate right to humble his nemesis NTT. Yahoo! BB's main draw, even more than superfast Net access, has been a voice-over-IP feature. It's an economical approach to telephony that allows Softbank to offer ridiculously low rates (less than 3 cents a minute for a call from Tokyo to New York). Son even foresees the not too distant day when VoIP calls are virtually free - the email of the 21st century.

If he's right, Yahoo! BB could herald the beginning of the end for NTT's fixed-line telephone business - a cataclysm for the Ma Bell of Japan - and portend dark days for doddering US telcos. But Son's not stopping there. His IP backbone is so robust, it has him eyeing Japan's TV industry, too. Last year, Softbank began rolling out a video-on-demand service that can cheaply pump Hollywood movies into Japan's living rooms - over the same 12-Mbps DSL connection.

Will Son survive long enough to see his huge bet pay off? Softbank's plan for making money isn't nearly as remarkable as its fancy new network. To a legion doubters, Yahoo! BB is a return to that most foolish of dotcom ploys: selling a dollar for 80 cents and making it up on volume.

Son shrugs off the skepticism. Broadband is good for the economy, he suggests, and a revived economy is good for Softbank's far-flung investments, from Yahoo! Japan to E*Trade. His peers acknowledge he's at least half right. "If Japan can create a broadband network that really works, the country will be able to get back to its core strength - marketing new technology at home and pushing it overseas," says Joichi Ito, CEO of the Tokyo VC firm Neoteny. If everyone in Japan can suddenly swap video, for example, imagine the impetus for consumer electronics firms to create cheaper, faster digital cameras. Or Wi-Fi phone handsets that can play movies.

"People say we're crazy, and maybe we are" was among the first lines I heard from Taro Hashimoto, president of Softbank Broadmedia, the subsidiary that manages the network's content delivery. It seemed like a rare instance of bluntness for a Japanese executive, but it's a rehearsed line from a playbook. Son later recited the identical quip.

To Son, crazy is a slightly warped outlook that sparks innovation. Of course, there's the other kind of crazy - as in Napoleon assuming the Russian winter wouldn't be so cold. Give Son's dealmaking record a scan, and he starts to look more like he's marching into Moscow in mid-September. In 1996, he bought trade mag publisher Ziff-Davis for an estimated $2.1 billion from Forstmann Little, which had purchased Ziff only 15 months earlier and flipped it to Softbank for a $700 million profit. By the time Son unloaded it, he was out a cool billion.

Softbank blew billions more on Asahi TV, Asia Global Crossing, SKY Perfect, and a throng of dotcom dogs: Kozmo.com, More.com, SportsBrain. Webvan? Yep, that was him. He envisioned setting up an independent Nasdaq in Tokyo, which would list the energetic startups that couldn't be found on the stodgy Nikkei. But government regulators nixed the idea. For Son, the whole Nasdaq experience amounted to another billion-dollar write-down - $1.2 billion, to be exact.

But all of Son's failures are overshadowed by one amazing jackpot: Yahoo! His investment has become a tale of dotcom prescience - and dotcom cojones. He wagered $374 million on Yahoo! between 1995 and 1998, a bet that, at its peak, increased in value more than 50-fold.

Now he's pouring money into Softbank subsidiary Yahoo! BB with the same vigor. It's easy to see why customers are flocking to high-speed, low-cost DSL: In Japan, monthly tolls for 56-Kbps users regularly exceed $90. Yahoo! BB's low price comes from the technology in its underlying network.

In the US, DSL still routes through asynchronous transfer mode switches, old-school phone equipment that's reliable but inefficient, prone to breakdowns, and profligate with bandwidth. Softbank's network opts instead for gigabit Ethernet switches, which transmit data via IP routers. Thanks to lower maintenance costs, a GbE network can be up to 100 times cheaper to operate than an ATM backbone - even while providing faster speeds.

And it handles voice like a dream. With traditional VoIP, a call is converted to data packets, which hop from an IP network onto a phone network, like NTT's, through ATM switches. But ATM switches were designed to handle old-fashioned phone calls. They tend to leak data, which erodes call quality. With an end-to-end Ethernet network, there is no ATM switching - "Our packets stay inside the network," says Hashimoto, "so there is no spill." The sound quality of a Yahoo! BB call is indistinguishable from a fixed-line call.

The difference is the price, and it's a whopper. Average rates are just a tenth of what NTT charges, and Yahoo! BB customers call each other for free. The number of subscribers has rocketed to 2.5 million since VoIP service was added in April 2002.

To NTT, which collects nearly 40 percent of its revenue from fixed-line calls, it's an alarming trend. "If toll calls just disappeared, it would crush them," says Ito. "The question is whether technologists can convince the financial analysts that phone companies are securing their bonds with equipment that isn't worth anything anymore," he continues. "If that happens, the phone companies could go ka-boom!"

For Son to benefit from such a seismic shift in telecom, he must first succeed with a company quite different from its namesake. Unlike the Internet portal, Yahoo! BB is capital-intensive. Before the first packet ever flowed, the network had cost Softbank $1.3 billion. Couple that investment with a huge customer acquisition budget, and Yahoo! BB needs to hold a subscriber for 15 months just to break even. That makes Son's gamble audacious - even by his own lofty standards.

As a Korean growing up on the southern Japanese island of Kyushu, Masayoshi Son was a frequent target of playground bigotry, despite his family's adoption of a Japanese surname, Yasumoto. He is not, however, a rags-to-riches story. His father ran a thriving chain of pachinko parlors. At 16, Son shipped off to California to learn English and eventually enrolled at UC Berkeley.

A born hustler, he imported cheap Space Invaders machines from his dad, renting them to laundromats and splitting the proceeds. He also patented a pocket-sized electronic dictionary and cold-called companies until Sharp bought it for $1 million.

Son founded Softbank in 1981 as a PC software distributor. It was lucrative work - but rather anonymous for the ambitious Son, who considered himself a worthy peer to the US tech elite. In 1994, he helped Cisco CEO John Chambers corner the Japanese router market by luring 14 companies to invest in Nihon Cisco; Son received a nice stake for his troubles and earned a reputation as a rainmaker.

A year later, flush with cash from taking Softbank public, Son began looking to buy up online real estate. Nicknamed "Mr. Internet" back home, he spoke of creating the cyberworld's premier zaibatsu, a pre-World War II term for Japan's vertically integrated conglomerates.

Another handle Son picked up was "the Bill Gates of Japan." His personal wealth was estimated at $76 billion in 2000, when he breathed down the neck of Paul Allen on the Forbes 400. He built a Tokyo technomansion to rival Gates' estate - the highlight being a programmable golf range that can precisely mimic a Pebble Beach fog or an Augusta dogleg. (Son brags that the course once spurred a visiting Gates to utter the ultimate compliment: "Wow!") Then there's his fondness for argyle sweaters, similar to Bill's frumpy threads.

American business held up Son as a model of the New Japan. It helped that he spoke fluent English, told ironic jokes, and shook hands rather than bowed. Son was the sort of chummy, outspoken Japanese executive that Westerners could safely embrace.

Then the markets buckled, exposing the less than rigorous decisionmaking behind Son's investments. For example, he once gave E*Trade $400 million based on a single phone call from the company's founder. Like so many Softbank companies, E*Trade has since flatlined, its stock price dipping to less than $3 from a mid-1999 high of about $60. (Softbank's current stake is worth $22 million.) And, of course, Son's own net worth has cratered to around $1.1 billion, a slide that makes him History's Biggest Money Loser.

There could be more carnage to come. Son has frequently been faulted for creative accounting. Even veteran analysts have trouble making sense of Softbank's maze of partnerships and subsidiaries. "Softbank's method of business is to shift money from one pocket to the other at an accelerated rate," says Ben Wedmore, an HSBC analyst and a vocal Son critic. "When the first pocket generates losses, you IPO the second. They've done it again and again."

No amount of financial engineering, however, can cover up Softbank's mounting losses. Despite profits at Yahoo! Japan, which has benefited from increased use of its flagship portal, the rest of Softbank's assets are dead weight. Last fiscal year, the company booked a record $842 million loss; in announcing the results, Son insisted profit could come "at any time." To some, Softbank's resilience defies logic.

"I thought it would be bankrupt by last August," says Wedmore.

To keep Yahoo! BB growing, Son is selling off other Softbank assets. He's already shed 16 percent of his Yahoo! Japan holdings. There's also the proposed sale of Aozora Bank, a huge controversy in Japan. When Son purchased the bank from the government two years ago, he promised that he'd hold on to it and nurse it back to health. The quick reversal is not endearing him to Tokyo politicians.

The sell-off has observers scratching their heads. "The company is holding on to the crappy stuff, and selling the really good stuff," says Neoteny's Ito. "Long-term, I could see Softbank opening the box and realizing that it sold its golden goose."

Son believes the route to profits lies in the loyalty of his customers. "Our churn rate is 1.5 percent or less," he says. "Our customers will definitely stay longer than 15 months, so that should be sufficient."

Until the churn increases, and it will. Japan Telecom, KDDI, and others are all rolling out low-cost DSL/VoIP services. NTT is offering three free months of service, plus price breaks on new PCs, and tapping deep government contacts to frustrate its rivals. In March, the behemoth lobbied the telecom bureaucracy to approve a 12 percent hike in interconnection fees, which it charges to IP telephony providers for the use of its fiber. The fees can be levied retroactively, which means Softbank could face a steep bill from its broadband rival.

Rather than playing financial chicken with NTT, Son's fighting back by adding features to his service. Now that VoIP will soon be commonplace, Yahoo! BB will be delivering TV and video over ordinary phone lines. Yahoo! BB compresses video content in MPEG-2 format and transmits it to customized set-top boxes outfitted with Ethernet jacks.

As advertised, the picture is every bit as crisp as a DVD. The system is also cheaper to deploy than fiber; upgrading a DSL household to TV-over-IP can cost a provider as little as $300, compared with the thousands necessary to build and maintain last-mile fiber. That's why Softbank headquarters teems with a stream of American and European delegations, all keen to learn more about Son's network and video-over-DSL approach. A few days after my visit, a group from Alcatel was slated to fly in, check out the demo, and head right back to Paris.

Too bad no one's gawking at the business model. It's unlikely that Yahoo! BB customers will spend another $21 a month, and an $83 installation fee, for 19 to 22 channels and a pay-per-view service. Hashimoto dreams of offering thousands of movies, but that means striking deals with Hollywood studios, notoriously jealous guardians of their content. And if Yahoo! BB can't upsell, it's toast.

Most financial analysts are betting against Softbank. Predicting the company's demise has become something of a parlor game in Japan. But Son pays the doomsayers little mind. As he sees it, Softbank stands to benefit from the type of head start that only true vision can provide. "In this industry, the first mover, the pioneer, very often gets a big success," he says, rattling off some of his favorites - AOL, Cisco, Dell, Intel, Microsoft. "These companies did not necessarily have big capital to begin with, but they had the vision and the passion."

The "first mover advantage" theory worked for a while. More popular nowadays is the first-mover disadvantage, the idea that innovators go bust, while the refiners get rich. Which would make Son a broadband martyr. And that's definitely not part of the big dream.


Contributing editor Brendan I. Koerner (koerner@newamerica.net) wrote about drug comebacks in Wired 11.06.



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